IMF calls for caution as ‘connect’ schemes move forward

Increasing links between Hong Kong and mainland China financial market could create more risks, risks that one global watchdog feels Hong Kong may not be doing enough to prevent.

The International Monetary Fund (IMF) feels Hong Kong could do more to strengthen monitoring of its world-class stock market as well as the monitoring of non-bank institutions, brokerage dealers and asset managers.

In a recent preliminary assessment on Hong Kong’s financial regulatory framework, the IMF said the international financial centre must continue to maintain close and regular surveillance on relevant risks in China to help the city prevent risks arising from expanding channels connecting financial markets in Hong Kong and mainland China.

A proposal named Primary Equity Connect (PEC) has received some attention this year, as it would open up capital markets to mainland investors and bring immense amounts of capital and diversity to the city’s stock market.

This new Connect scheme would add to the existing Shanghai-Hong Kong Stock Connect launched in November 2014, the Shenzhen-Hong Kong Stock Connect launched in December 2016 and a bond market connect scheme launched earlier this year.

However, some analysts worry that the connect schemes could bring to Hong Kong markets the level of volatility that is frequent in China’s markets.

“The proposal has yet to be approved, as the new registration system under the proposed connect could create some concerns of fraud or false documentation,” said a lawyer at Hong Kong-based firm Gallant Y T Ho & Co who asked to remain anonymous said.

“The delay in the move may be due to concerns that without officials to examine and approval such listing proposal, the problem of inaccurate documents and financial data might be more serious and harm the health of local stock markets.”

In fact, the HKEX has said itself that there are “legitimate concerns” in connection to the implementation of the PEC, and that sound market regulation for the PEC will have to be established to ensure a fair environment for investors, and to provide adequate investor protection and risk control.

Charles Li Xiaojia, chief executive of HKEx said in September that the clearinghouse is working with regulators from both Hong Kong and mainland China to explore ways to connect investors, but refused to give a timetable on the PEC initiative.

“This new plan still needs a lot of parties to discuss the details. What I can say is this new Primary Connect will benefit both the Hong Kong and mainland markets,” Li said.

It is not difficult to understand why concern is growing about the importance of ensuring the stability of financial market in Hong Kong and China, as the country has shown in the past that without sufficient regulatory protection, investors are prone to panic buying and selling that poses risks to the financial system.

Case in point was the summer of 2016 when China’s investors flooded into the market after an impressive rally, which eventually led to one of the biggest collapses in recent history.

Warnings from analysts around the world that suggested the Chinese market was overheated and the valuations of many listed companies were approaching irrational levels. The subsequent collapse erased trillions of Renminbi from the country’s stock market in a matter of days.

The Chinese government has stepped up its regulatory effort since then.

In November, China’s planning agency, the National Development and Reform Commission (NDRC), issued guidelines to prevent tax fraud, money laundering, illegal financing and activities that might damage the country’s reputation, also focus on cross-border capital flows.

The regulators have reiterated multiple times that they would maintain or even step up their efforts in beefing up the management of financial risks.